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How to Make a Fortune with the Reflation Trade

Ted Peroulakis — Thu, 23 Jul 2009 16:17:16 +0000

America is witnessing a mammoth increase in the money supply. According to the U.S. Federal Reserve, seasonally adjusted M2 has gone from $7.25 trillion in July of 2007 – to over $8.37 trillion today. That’s 15.44% more money circulating around the economy in just two years, a colossal $1.12 trillion increase.

This phenomenon will push price inflation much higher, giving you an opportunity to profit on the “reflation trade” that will play out over the next decade.

M2 is calculated by totaling up the value of cash held by the public, checkable deposits, household savings deposits, small time deposits, and money market mutual funds. M2 is an important economic indicator used to forecast inflation. If you have too much money or M2 awash in the economy chasing too few goods and services, the result is higher inflation.

Since the start of this global economic crisis, the U.S. government has been injecting massive amounts new currency into the financial system to prevent deflation and stimulate economic growth. This is referred to as reflation.

This large injection of currency into our economy will certainly lead to higher inflation, which will be further amplified due to our fractional reserve banking system. In a fractional-reserve banking system a new sum of money is created whenever a bank gives out a loan. Here’s how it works…

A U.S. based bank is required to keep only 10% of deposits in reserves. They can loan out the remaining 90% of the deposits. This money multiplier effect tends to enlarge money in circulation by tenfold. For example, if you deposit $10,000 in a bank, the bank is required to keep only $1,000 of your money on reserve and it can lend out the remaining $9,000.

Essentially, the bank has turned $10,000 into $19,000 by giving you a $10,000 credit on your deposit and then lending the additional $9,000 out to someone else.

Now, if the bank does this over and over, your original $10,000 deposit can become $100,000 under our 10% fractional reserve banking system. Here’s how:

You deposit $10,000–The bank loans someone else $9,000

That person deposits $9,000–The bank loans someone else $8,100

That person deposits $8,100–The bank loans someone else $7,290

And so on…

Eventually, your initial deposit of $10,000 can grow into $100,000 under a 10% reserve requirement. Every new dollar that is injected into our economy can essentially become ten dollars.

Bottom line: The massive amounts of new currency being dumped into the U.S. economy will be multiplied under our fractional-reserve banking system, which will lead to higher inflation. This will be a disaster for savers, whose nest eggs will be devalued. But it can be quite profitable for those who are prepared.

What is the reflation trade?

We will see a large spike in prices for goods and services when we finally emerge from this global economic crisis, which could be within a year. Hard assets like oil, gold and agricultural products will see substantial price increases in the coming high inflationary environment. Commodities will be one of the strongest sectors over the next decade or more.

This huge underpinning force in the equities markets opens up an once-in-a-lifetime trading opportunity. Here are my top reflation plays:

HAP – This ETF closely tracks the Hard Assets Producers index which consists of over 250 companies engaged in the production and distribution of hard assets and related products and services.

GLD – This gold tracking Exchange Traded Fund (ETF) mirrors the price of gold.

SLV – This silver tracking ETF mirrors the price of silver.

DBA – This ETF tracks widely traded agricultural commodities like corn, wheat, soy beans and sugar. As agricultural prices rise the price of this ETF goes up.

MOO – This ETF comprises a basket of companies engaged in various sectors of agribusiness, like agricultural chemicals, livestock operations, agricultural equipment and ethanol/biodiesel.

PCL – One of the best timber producer stocks. Historically, timber prices have done exceptionally well under inflationary circumstances.

FCX – Freeport McMoRan is one of the world’s largest copper producers. This stock goes up when copper prices rise.

XOM – Buy Exxon Mobil stock to invest in oil. XOM is well positioned to benefit from higher crude oil prices and is one of the best managed companies in the energy sector. XOM has increased its dividend for 26 consecutive years and has excellent earnings, dividend growth and stability.

Source: How to Make a Fortune with the Reflation Trade

The Fed Has Completely Rewritten its Mission

Bud Conrad — Wed, 12 Nov 2008 13:26:44 +0000

Under Bernanke’s direction, the Federal Reserve has completely rewritten its mission. Many articles in the International Speculator and The Casey Report have reported the strange growth in the loans they have made and explained that Bernanke has, for a long time, espoused unconventional actions to avert deflation and to expand the economy. So the charts below tell that story, and it is truly amazing.

The Federal Reserve was never envisioned to be lender of last resort to a whole slew of investment banks, money market mutual funds, and commercial paper issuers.

The situation is not easy to sort out, for the simple reason that the extent of their actions is not presented by the Fed via clear and concise data. Instead, the data is complex and hard to analyze, partly because of the piecemeal way the actions were taken, but also probably due to a desire by the Fed to avoid public scrutiny and criticism.

Digging into the details of the Fed’s balance sheet reveals, however, the complete change of composition and direction of the Fed. The most obvious change is that they have doubled the size of their assets and liabilities. A year ago, the Fed’s assets consisted almost entirely of government Treasuries and a little gold.

That is a clean, safe balance sheet.

The only important liability was the currency they issued (our paper dollars). They also had a small reserve of deposits from all the banks. When Greenspan wanted to give the economy a boost by lowering short-term interest rates, he would create some money and buy Treasuries. He could also do the reverse.

Bernanke has turned this upside down. Initially he made focused loans to big banks. But then the loans became bigger than the reserve deposits, leaving the banks in total as net borrowers. The concept of a fractional reserve no longer applies when the reserve is net negative.

To fund yet more loans, Bernanke then sold off half of the Fed’s Treasuries. And he traded Treasuries for toxic waste of poor-quality mortgage-backed securities. And he encumbered half of the remaining Treasuries with “off balance sheet” swaps of about $220 billion. (Does this sound like Enron accounting?) The balance sheet started with $800 billion of mostly reliable assets and now has about $250 billion of unencumbered Treasuries.

The biggest source of funding is from the Treasury. Banks are leaving deposits in the Fed now that the Fed is paying interest.

The important conclusion is that the paper dollars are now issued by a far less soundly structured Fed, an organization that is more interested in bailing out the financial community than defending the dollar.

This chart below compares last year’s assets, which were mostly Treasuries, to this year’s twice-as-large and far more questionable mix:

The other side of the balance sheet shows that the Fed has borrowed and taken in deposits to fund the loans that are as big as the issuance of currency. In effect, the Fed has doubled its footprint and doubled its responsibilities. Mostly under the covers, they added almost $1 trillion new credit to the financial world in about two months.

There are additional important Fed actions not included in their balance sheet. For example, they invented a Money Market Investor Funding Facility (MMIF) to guarantee up to 90% of $600 billion of loans to that sector. They do this through special-purpose vehicles established by the private sector (PSPVs). The latest Commercial Paper Funding Facility (CPFF) started October 27 and has issued $143 billion so far. These are both in addition to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility initiated September 19. The programs are beyond keeping up with.

Nothing like this has ever been done before by the Federal Reserve. In time, the consequences in terms of confidence in the dollar will be bad.

Bud Conrad is the chief economist of Casey Research, LLC., providing fiercely independent analysis and investment recommendations for subscribers in the U.S., Canada, and over 150 other countries around the world.

Powerful forces are at work in the economy; a global tidal wave of bank failures, credit crises, and sky-high debt. The central banks of the world may not be able to stave off what’s coming — but you can protect yourself and profit… by catching one of the massive market riptides Casey Research identifies every month in The Casey Report. Don’t miss the lifeboat that can take you to financial safety. Learn more here.

Source: What’s Up, Doc?